The Balancing Act: Saving For Retirement vs Paying Down Debt (Part 3 of a 3-Part Series).
The battle of paying off debt vs saving for retirement continues to wage on and there are proponents in both corners of the ring. So far we’ve look at the black-and-white scenarios of saving for retirement versus paying off debt.
In the first article we looked at getting aggressive with our debt repayment plan. Next, we talked about delaying paying off our debt and instead putting that additional capital towards saving for retirement right out of the gate after graduation.
In this last installment, we’ll look at the outcome of using that one word that every married couple should learn sooner rather than later: a compromise.
To reset the table and make sure we’re clear on the circumstances of the situation, let’s look at the scenario. Our 25 year old new grad optometrist has recently graduated with $200,000 in a 30-year, federal consolidated student loan at 6.8% and is making $100,000 as a W-2 employee of a practice. Taking taxes into consideration, here is their (estimated hypothetical) net income calculation:
|Average Federal Taxes (18%)||(-) $18,000|
|FICA & State Taxes (7.65% FICA + Ave 5% State)||(-) $12,650|
|Net Income||$69,350 ($5,779/mo)|
I feel I have done a disservice up to this point, but it has been intentional.
Think about it. If you overleverage yourself with a high new car payment (or, even worse, a high lease payment), have an expensive mortgage or rent payment, and spend every cent of your leftover, discretionary income, the information from this article will be similar to a huge bowl of food sitting 12 feet away from a dog on a 10-foot leash: you can see it and know the benefits, but it’s out of reach.
Everything that we’re talking about is predicated upon you having additional income to allocate towards debt repayment and retirement planning. You may be asking yourself “So how much should I spend on a mortgage?” or “What’s the best way to buy a car?” or “How much should I spend on insurance?”
(In marketing, this is called “a tease.” We’ll make sure to address this topic in more detail in future articles. Back to our regularly scheduled programming).
Let’s first take another look at the numbers behind the consolidated student loan and the total cost for that part of the equation with just making the minimum monthly payments:
Still abiding by the scientific method, we’re going to stick with our monthly nut of $2,500 to be used towards the combination approach of debt repayment and retirement savings.
But rather than put all $2,500 towards one or the other, we’re going to split this up a bit and I’ll do my best to be clear about the method we’re using here and my philosophy on why I did it this way, but it comes back to that word we used earlier: compromise.
Shifting our goals:
Rather than focusing on the debt, I want to focus on the retirement goal for this young OD. I know retirement seems a long way off, but I phrase retirement as being “financially independent” and “working because you want to work, not because you have to work.”
If we take the basic retirement age of 65 and we want to provide a retirement scenario that allows our OD to continue a similar quality of life as they’re used to right now, here’s the “recipe” I’m following and the outcome of this approach:
- The monthly “debt snowball” that we’re paying towards student loans is $1,834/mo. Paying this amount equates to the following results for student loans and our OD is debt free at age 39 (in 2030)
- We begin saving the following into our retirement accounts
|Order of Priority||Type of Account||Monthly Investment||Annual Amount|
*The 401(k) may not be available if your employer has not implemented a qualified retirement plan like a 401k. In that case, this investment amount would be invested into a taxable investment account without the tax advantages of a 401k. This illustration also does not include any potential employer matches, which would also impact the outcome.
- This savings strategy continues until becoming debt free in 2030, at which time he takes approximately HALF ($900/mo) of what we were paying towards student loans and pay ourselves through our 401(k) instead of Sallie Mae. This now increases our total annual savings into our 401(k) to $13,300.
- We continue this savings strategy along with our Roth IRA savings straight through to age 65.
The outcome and explanation:
Implementing this strategy gives us the following portfolio values in the future:
|55||2046||Original Debt Term||$1,191,707|
Here are some important assumptions to understand, which NEGATIVELY impact the outcome:
- We’re assuming the savings rates stay the same. That is to say we’re not increasing our Roth or 401(k) savings strategy incrementally each year as we get raises, increase our income, etc.
- If we work for an employer that offers a match on the 401(k), this is a big benefit! Push your employer to offer a match (even in lieu of a raise!!).
- We’re assuming an 8% rate of return. While that’s an average, if your investments average even 1% higher, that increases the portfolio value at age 65 $3,614,614.
- While our savings rate is the same we ARE increasing the cost of living between now and retirement to keep pace with inflation. Doing one (increasing expenses) while not adjusting the other (savings rate) works against us, but we’re trying to understand a “worst case” scenario.
- It assumes we do not marry and add an additional income stream and savings strategy into the plan. (Side note: hopefully that other income stream does not tow behind it the same ratio of income: student loan).
In the end, when we “test” this plan using a Monte Carlo analysis against retirement expenses of $60,000 (expenses, not income) or $5,000 per month, we have a 67% success rate. Not bad, considering the goal of retirement is to retire debt free (including your house) and similar to what we were living on while we were working (see first table).
Optometry has changed.
Both in a business model and educational setting. Before you tell me I’m crazy because I’m not an O.D., hear me out. While I’m not an O.D. by schooling or profession, I know your profession much better than a lot of other authors on this topic.
As the husband of a practicing OD (2011 graduate from Indiana University) digging out of our own student loan mountain and running a financial services practice that is focused on serving practicing OD’s and their families, I see and live it every single day.
The cost of education to become an optometrist has increased significantly at the same time that incomes have come down, especially in the private practice model as an associate OD, which is where you may find yourself shortly after graduation (as my wife did).
Price competition from retail optometry has compressed the business models of the traditional private practice, which in turn has compressed the operating margins of a private practice.
Let’s not even get into managed care.
If you choose to go the option of starting a practice cold, you can easily find yourself $750,000 – $1,000,000 in debt with three transactions: house, student loans, practice debt (depending on how you structure the three transactions).
Why do I bring this up and seemingly take the wind out of your sails?
I don’t do it to depress, anger, or cause regret of your profession. According to the US Dept of Labor (and just a common analysis of our population), optometry has been ranked to be an “in demand job” and one that will experience a higher growth rate with an aging population and advances in medical optometry. I do it because, even in the face of a dynamic profession like optometry, you still have to own your situation and circumstances.
But all of these changes require planning—personally, professionally, and financially.
As Benjamin Franklin says, “Fail to prepare and prepare to fail.” With the margins and outcomes that we’ve discussed over the series of these articles, the cost of not following a plan can be “six-figure large” mistakes.
They require discipline.
They require sacrifice.
They require perseverance.
They require accountability.
All good qualities and traits that successful optometrists possess and implement into their lives on all fronts. You’ve invested far too much money, time, education, and effort to not capitalize on your income.
It’s time to make a plan.
Some of the most successful optometrists that we work with understand that they are smart enough to know that they don’t know it all and make it an effort to surround themselves with trusted advisors and alliances that are truly focused on their success.
So if what we’ve talked about over the course of this three-part introduction to our continued sharing of financial information has struck a nerve and you’re wanting to take action, take it.
Do it now.
Don’t wait until next week, next month, or next year.
Putting together a great financial plan is just like having kids—life will never fully cooperate and there’s never a “good time” to have kids. The same rings true for building, strategizing, and executing a solid financial plan.
If you’d like to learn how to start that process, we’d be privileged to have that introductory conversation with you.
Until then, best wishes for continued success in your practice and in life.